The 12th-century military disaster that forever changed global finance

From the article:

The birth of the bond market started with a ruthless multinational raid that sent shock waves through the Mediterranean. On the morning of March 12, 1171, the Byzantine emperor’s soldiers suddenly rounded up every Venetian man, woman, and child they could find throughout their lands, seized their shops, wares, and ships, and threw the owners in jail. Over 10,000 people in Constantinople alone were rounded up, and more than 20,000 overall — so many that monasteries were requisitioned to handle the overflow. The raids were a consequence of more than a century of rising tensions between Constantinople and its nominal vassal in northern Italy.

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The Italian statelets typically taxed modestly and covered larger expenditures with ad hoc loans. These were often backed by security in a specified state asset or revenue stream, such as toll receipts. For example, in 1164, Venice had borrowed about 270 kilograms of silver from a dozen of its wealthiest families, and in return granted them 11 years’ worth of its income from the Rialto market. But the scale of the navy needed to take its own sovereign down a peg meant that heading down to the Rialto market to hit up its moneylenders wouldn’t suffice.

The doge had a drastic solution. He divided the city into six districts, systematically assessed the wealth of its citizens, and forced them to hand over the money Venice needed for its fleet. But rather than a straightforward one-off war tax, it would be a loan, albeit an involuntary one. Venice promised to pay its citizens 5% a year until the debt could be repaid. Crucially, the receipts of the prestiti — the plural of prestito, or loan — were made tradable, so a citizen who needed to raise money could sell their claim to someone else at a discount if necessary.

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Then disaster struck. The moored Venetian fleet at Chios was hit by the plague, with more than a thousand men dying in just the first few days. It desperately started moving from one Greek island to the next, but remained just as blighted by disease. Then the Venetian ambassadors returned from Constantinople with bad news: The emperor had refused to even see them.

With his armada slowly dying and no longer a credible threat to Constantinople, Doge Vitale returned to Venice with what remained of the fleet in May 1172.

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Another oddity that persisted for a long time afterward was the loan that Venice had imposed on its citizens. Shut out from Byzantine ports — it would take almost two decades to reach a truce with Constantinople and get the prisoners released — and financially stricken by the failed venture, Venice did not have the wherewithal to repay the prestiti as planned. What was initially an involuntary emergency loan in practice became a permanent mountain of state debt.

Venice did maintain the 5% interest payments, setting aside tax revenue from the Rialto stalls to cover them. To reassure its anxious creditor-citizens, transparent records of all revenues and payments were maintained by Venice’s Procurator of Saint Mark — a kind of deputy-doge-cum-finance-minister. Eventually this job went to the city’s Great Council, reinforcing its importance. This body was dominated by the city’s wealthiest families, who as both creditors and citizens had an interest in ensuring that Venice did not simply abrogate its debts as many absolute monarchs around Europe often did, ruining many banking houses in the process. Whenever a new war or financial emergency broke out, the Great Council would mandate the issuance of new prestiti.

The credibility of the regular and fixed interest payment, coupled with the tradeability of the debt, transformed what was initially an annoying reminder of Venice’s humiliation into a monument to its commercial genius.

Now, anyone in Venice could take money they had saved up and convert it into a future cash flow — perhaps to secure some income for when they retired, endow a charity, or give away as a dowry. They could use the prestiti as collateral for other loans, or as surety for goods. And if they needed to get back their money — or were worried about the solvency of Venice — they could head down to the Rialto market and sell their claims to the bankers, speculators, and merchants who had started to actively trade the prestiti there.